I wouldn't bet your bottom dollar on it

HOW times change. Just six years ago one pound would buy you just $1.37; now you can get a brace of dollars for the same money.

Over the same period, Consumer Price Index (CPI) inflation in the UK has averaged 1.7 per cent against a fraction over 2.6 per cent in the US. Real GDP growth has averaged just below 2.5 per cent in the UK, just above the US. The UK's base rate has averaged 4.4 per cent, US Fed Funds 2.7 per cent.

If an exam question gave you those variables and asked your thoughts on the currency, you would be likely to posit a trend of a weakening in the dollar.

Unless, that is, you were a maverick. And maverick thinking is not lightly to be dismissed in the currency markets, fond as they are of turning logic on its head.

From under $1.40 to over $2.00 is, however, rather a large change, probably rather greater than you would dare to suggest in your exam answer. So does it really make sense and is it reasonable for the consensus to have rushed to predict a rapid further decline to $2.10 or beyond?

It is always hard to be sure what factors drive changes in exchange rates. Over the long term I base forecasts on differential real GDP growth - rising currency is the manifestation of relative enrichment. The definition of "long term" is elusive so the concept is not as useful as it looks and shorter term it will frequently be quite misleading. But at least it gives you a fair stab at the direction.

Within a trend, though, currencies have a penchant for contrary moves, often lengthy and substantial. Through 2005 the dollar strengthened by some 11 per cent. These shorter-term shifts tend to be driven by changes in interest rate differentials; through mid-2004 to early 2006 the Fed Funds rate was on its long climb from 1 per cent to 5.25 per cent while August 2005 saw a cut in UK base rate.

Even here, though, the tendency for currencies to wander off on seemingly random walks can frustrate rational expectations. Most obviously this can be the product of investors' bizarre habit of leaping to the wrong (usually instant) conclusions about likely interest rate trends. Often these leaps last for mere seconds; sometimes for days or weeks.

If all this leaves you thinking that currency forecasting is something of a mug's game, then that's because it is. Strategic asset allocators have some chance of decent long-term guesswork, yet many remain puzzlingly determined to play short-term trades too. That this is a largely futile quest seems not to deter.

SO WHAT to make of the dollar today? Increasing evidence of slowdown in the US, punchy inflation numbers in the UK and better news from Euroland have convinced investors that the interest rate spreads are set to swing against the dollar. So with cable through the psychologically important $2 level, it was "obvious" that the next stop would be $2.10.

Two dollars does indeed have something of a chart break look to it and it is a brave commentator who would take an aggressively contrarian view. Yet the contrarian view is often the right one.

Adding some flesh to the hunch, it is likely that people have become a little too worked up about UK inflation after the letter-prompting 3.1 per cent CPI print for March.

UK rates will indeed establish a quarter-point (perhaps half-point) premium over Fed Funds but it is a moot point whether that justifies another ten cents of dollar depreciation. It feels suspiciously as though this consensus target of $2.10 is a product of forecasting by rule rather than thought. It is tempting, then, to see the right short-term trade here to be going long dollars.

Supporting that hunch is something writers on the weekend travel pages have clearly picked up. With sterling at $2, real price differences between the UK and the US are extreme. Purchasing power parities have gone barmy. Currency markets do not explicitly pay much if any attention to the purchasing power of the tourist pound but the current parities argue that sterling is if anything overvalued.

The object of the exercise here is not to make a particularly strong case one way or the other for the dollar against sterling. Indeed here actually is the whole point: the entire investment community seems to take it as a given that the trend of the past six years will continue and that shorter term the latest bout of weakness will turn into a mini-rout. Maybe this reflects the popular belief that issues are always cut and dried - always either black or white. Realists know that the world is actually made up of shades of grey.

Contrary to the consensus, maybe we should spare a moment or two to wonder whether the move we have seen over the past six years might actually be enough.Maybe mavericks rule, OK?

• Peter Bickley is director of economics at Tilney Private Wealth Management